It was a relatively quiet week in the markets, and with exchanges closed after Friday's well-below-consensus U.S. employment report, it stayed quiet (though it may be very active next week).
There wasn't much movement this week in any of the major developed-market indexes. China did make headlines, however, as its central bank moved to reduce the down-payment amounts necessary for a second home in hopes of stimulating the country's soft residential housing market. Emerging-markets stocks rallied 4% to 5% on the news.
Economic data out of the U.S. was sloppy, capped off by a jobs report for March that disappointed many but wasn't a huge shocker to us, as employment had been outpacing GDP growth by an unsustainable margin. The March number was disappointing, but it had to come down at some point, and I'm not panicking about this report at all. Businesses perhaps excitedly geared up to boost hiring last fall and implemented those plans early in 2015; now they have backed off. I still estimate that we will average 250,000 jobs a month this year. Many other employment metrics continue to tick up, including hourly wage growth and initial unemployment claims, which fell by 20,000 (near the lowest level in 15 years) in the week ending March 28.
Comprehensive, inflation-adjusted consumption data showed consumer spending (which is 70% of the U.S. economy) actually went down in February. However, recall that February weather in the Northeast was horrendous, and we've already seen signs of a bounce-back in more-recent weekly retail sales data. Given the heavy snow, February was just a tough month for many to shop, and utility bills were also high.
On a more positive note, auto sales for March (reflecting more recent data than the consumption report) showed 17.1 million units sold (on a seasonally adjusted annual run-rate basis), the highest March number going back to 2000. Auto sales are one of the best indicators of consumer confidence, so this may be a sign that consumers are emerging from their malaise and could show some strength as we move into the spring.
Despite poor weather, pending homes sales increased over 3% in February; we've now had a couple of months of solid improvement, which bodes well for existing home sales. Combine that with last week's strong new home sales and also this week's Case Shiller pricing data, and it looks like the housing market could be turning the corner following a tough second half in 2014.
Economy showing softer side; no reason to panic
The economic data lately has been soft, topped off by this week's crummy employment report. We warned you. Since the fourth quarter, we have been whining that 2015 growth estimates of 3% to 3.5% were way too high. We cautioned that a slowing manufacturing economy, a strong dollar and the impacts of slower growth in the oil patch were likely to keep GDP growth in a range of 2% to 2.5%. Deteriorating demographics, including a shrinking working age population, won't help matters.
I know some of our whining was disheartening to many readers, and we were way too early on our employment warnings, but recent downward revisions mean that we weren't as far off as we had feared.
But now that the bad data has arrived, with a little help from our friends at the weather bureau, it is no time to panic, even if the official metrics show little GDP growth in the first quarter. Although the month-to-month economic data may remain scary for another month or two, the year-over-year trends have yet to break downward across most economic metrics.
On the optimistic side, a lot of the more-forward metrics have come out of hibernation, including new home sales, pending home sales, home prices, initial unemployment claims and weekly shopping centre data. In addition, the weather has begun to break and the consumer has a lot of dry powder to spend, as the saving rate remains unusually high. With 
Wal-Mart WMT, Target TGT and now McDonald's MCD raising their minimum wages, consumers will have even more money to spend.
So we are not in a free-fall situation, even if we have all underestimated the impacts of a strong dollar and falling energy prices. However, higher wages and slower economic growth may not be great news for corporate profits.
Headline trade deficit falls sharply on port strike
On the surface, the trade deficit looked stunningly good, falling to $35 billion (all figures are in U.S. dollars) in February, the lowest level since 2009 and a decline of over $7 billion from the prior month. A collapsing deficit comes as somewhat of a surprise, given the strength of the U.S. economy and the falling dollar. One might have suspected that the weak dollar would make imports cheaper, and seemingly flush U.S. consumers would pick up some of those cheap foreign goods. Instead, imports of goods shrank a stunning $10.3 billion. Exports were also weak, declining by a more manageable $2.9 billion. I would have guessed a greater fall in exports given the dollar strength.
It certainly appears that the West Coast dock strike had a major impact on the data. That strike was settled on Feb. 21, but not in time to make the February trade report. We suspect that it will take more than two months to clear the backlog at the West Coast ports. I would also guess that a lot of imports, especially from China, were concentrated at West Coast ports while U.S. exports went through a wider variety of ports, or by land to Canada and Mexico, the largest U.S. trade partners. If our thesis is correct, imports should soar in the months ahead while exports continue to meander downward.
Shifting prices, especially in oil, are skewing some of the data. The monthly trade deficit improvement of $7.7 billion drops to just half of that, or $3.8 billion, when we adjust for the effects of deflation. Also, if examined on an inflation/deflation-adjusted basis, it is only the lowest trade deficit since November 2014 (and not way back to 2009).
As usual, our year-over-year averaged data provides a much clearer picture of what is going on in the trade world. First, looking at the export side of the equation, nonoil-related exports are clearly trending down. The three-month moving average of export growth has dropped from 4% to 2.2%, and on a single-month basis the export growth rate has already fallen to 1.9%. This isn't great news for exporters, which will see even more effects from the slumping dollar. However, the fact that exports have held up as well as they have is a tribute to U.S. exporters and to the mix of products shipped. Drugs and airliners, two key export categories, continue to show strong year-over-year growth in the first two months of 2015. And some of the weaker categories--including oil drilling equipment, agricultural equipment, soybeans, and excavating equipment--have more to do with slow end markets than the effects of a strong dollar. Auto and computer exports have also performed poorly year to date, and those may indeed be because of a stronger dollar.
Although the import data took a deep swoon in February, when adjusted for inflation and excluding oil, the year-over-year averages show amazing stability, growing at a very consistent 5%-7% growth rate. That's why we are so sure that the dip in February was primarily due to port or reporting issues. However, there were some non-port-related issues that showed up in the February report. A lot of categories--including drilling and oil field equipment, industrial machines and excavating equipment--are looking a little soft recently, potentially related to the shale oil boom. Apparently it wasn't just U.S. manufacturers that were benefiting from the U.S. oil boom.
A lot of housing-related imports, like furniture, appliances and televisions, looked a little soft in February. (The housing industry has been in a bit of a slump since late 2014.) Those may rebound somewhat later in the year, when the housing market should begin to improve. Cell phones, a highly volatile market, had a dismal February, perhaps because of the lack of new and exciting models.
Despite the seemingly large trade deficit improvement in February, it's highly likely that trade will be another big hole in the March-quarter GDP report. Strong-dollar issues are likely to intensify for exporters, and the port backlog has had a disproportionate effect on imports, so the clearing of the ports is likely to cause a surge in imports, and the trade deficit, in March. Combining that with the January and February data we already have, we believe that net exports are set to subtract at least 1%, if not more like 1.2%, from the first-quarter GDP calculation. This is slightly worse than the 1.03% subtraction from the fourth-quarter calculation and the healthy 0.8% contribution to the third-quarter GDP calculation. Inventories of materials still stuck on the dock, or recently released to the supply chain, may mitigate some of the net-export-related hole.
For the world economy, even the relatively lethargic growth in exports to the United States is problematic. Healthy U.S. consumers picking up cheap foreign goods was supposed to be one of the key benefits of central bank actions and quantitative easing programs. This is especially important to non-U.S. economies that typically derive 25% or more of their GDP from exports (compared with just 13% for the United States). A stronger U.S. housing market and more consumer spending should help imports and the world economy later in the year. However, a U.S. consumer who seems more interested in buying services (or may be stuck purchasing them, in the case of insurance, electricity, natural gas, and rent) could limit the increase in imports.
Like a lot of other things, the oil shale boom may have benefited countries exporting oilfield equipment and supplies more than was commonly realized, too. Exports of autos to the United States are likely to remain under some pressure, too, as consumers favour trucks and SUVs over autos, which in turn strongly favours the Big Three auto manufacturers over foreign importers. All in all, the world economies may not benefit as much as hoped from a strong dollar and a strong U.S. economy.
Consumption report spells more trouble for the first-quarter GDP report
U.S. consumption grew only 0.1% between January and February (that is, only 1.2% annualized) before inflation, and it actually shrank by 0.1% after adjusting for inflation. This marks the third month in a row of monthly subpar inflation-adjusted growth rates (0.1%, 0.2% and now negative 0.1%). This happened despite the supposed cash in consumers' pockets from falling gasoline prices. Certainly, awful weather in the Northeast took its toll on recent data. And it wasn't for lack of income, either, which has moved up 0.5%, 0.9% and 0.2% over the past three months.
Even with estimated consumption month-to-month growth of 0.3% or slightly more in March--the final month of the first quarter--annualized consumption growth for GDP purposes is likely to fall from more than 4% in the fourth quarter to under 2% in the first quarter. Given the 70% weight on consumption, the contribution from the consumer is likely to fall from 2.8% to 1.4%. Combining that with a negative contribution from net exports, GDP growth would be barely above zero before adding in government and investments, which aren't likely to be a big help. That will leave just inventories to potentially save the day.
That's the simple math of the GDP calculation, done on a sequential quarter-to-quarter growth rate in both GDP and consumption. As usual, lately, the year-over-year data paints a different and more optimistic view of the world. Using a year-over-year methodology strips out most the of seasonal adjustment factors that have been nearly impossible to get right. On the consumption side, the year-over-year growth rates look higher and have been generally trending higher. The relatively healthy and steady year-over-year data are in stark contrast to the highly volatile month-to-month data.
The same year-over-year, averaged methodology applied to both real disposable income and wages shows a similar, more realistic pattern. However, even using these smoothing techniques, incomes and wages have both continued to outstrip consumption by a lot.
At the moment, wages and income are both growing at about a 4% rate; consumption growth is just over 3%. I do caution that income data lately has been prone to downward revisions. Still, the current gap seems unusually wide and is confirmed by the current 5.8% savings rate. We think a combination of poor weather and uncertainty regarding the sustainability of low oil and gas prices has probably caused the consumer to limit spending. However, if consumers do one thing well, it is spending almost all of their cash. Savings rates generally don't stay high for long. We suspect that consumption will be making its way back up to at least income growth levels in the relatively near future just as they did last year.
It's also interesting to note that the weak short-term consumption data and even a possible zero GDP growth rate on a sequential basis will not be enough to destroy year-over-year growth trends. Even in that tough scenario, four-quarter-over-four-quarter GDP will still be 2.6% and first-quarter-over-first-quarter growth is likely to push 3%, though weather is inflating the latter figure.
Some housing data signals strength, but inventory levels remain low (by Roland Czerniawski)
U.S. pending home sales advanced 3.1% in February, blowing away the 0.3% consensus estimate. Year over year, the growth looked even better at 12%, but that is at least partially because of an unusually slow winter season last year.
That wasn't the end of the surprises. The Midwest, considered not to be exactly the definition of a hot real estate market, exploded 11.6% month to month after treading water for months. The strength of pendings in the Midwest is probably a combination of low rates, an improving labour market, and rapidly rising rents, according to NAR's Lawrence Yun. In our opinion, this still hardly explains why the Midwest would do exceptionally well, but it does prove that real estate market conditions in the United States can vary greatly among regions, and they often behave idiosyncratically. This is what makes housing market particularly difficult to analyze, especially on the short-term basis.
We would be cautious to call it a definite sign of robustness in the housing market, especially as the first-time homebuyer market appears to be still depressed, and inventory levels are unusually low. The inventory issue is especially problematic in the South. Bloomberg has reported anecdotal news about homeowners who had no problem selling their existing homes, but were sucked into renting for longer than they expected because of low inventory levels of homes for sale. Eventually those inadequate inventory levels make homeowners reluctant to put their homes on the market out of fear of not being able to find a new place right away. According to the Texas A&M Real Estate Center, the inventory metric for the Dallas area is now at 1.8 months, its lowest point since the inception of the data in 1990. Healthy inventory levels are a key to a sustainable housing market. The low-inventory problem has affected many regions already beyond the South, and it is something that will be on our radar going forward.
Home prices are also related to inventory, and Case-Shiller, which is the last reported of the three indicators we track, confirmed what the other two, FHFA and CoreLogic CLGX, were already telling us. Home prices have been now increasing for a few months in a row, and the trend-telling year-over-year three-month moving average is up again. The faster pace of home price growth hasn't reached a point where it would be problematic, but it would be alarming if this trend continued. Higher price growth leads to lower affordability, and that has proven to be notably detrimental to the housing recovery. The current increase in price growth is related to the exceptionally low inventory levels in many regions, and it is still not clear whether that is more of a temporary obstacle or a longer-term problem. This spring could be crucial to helping us determine that, as those are the months that home inventories typically rise from their winter lows.
It's no secret: manufacturing continues to slow
This week's ISM purchasing manager report continued to show a slowing--not panicky--manufacturing sector. The pace of deceleration has continued unabated since October and peaked way back in August. That weakness is now clearly visible in the month-to-month industrial production data that are now down three months in a row. The year-over-year data is at its early stages of deterioration, with more bad news likely with the softer March ISM report this week and a weak durable goods report last week.
The weakness in the ISM data was rather broad-based with just current production levels and prices paid subcomponents showing increases. Employment data was particularly weak, with that index dropping to 51.4, marking a second straight month of sharp declines. ADP payroll data suggested that March manufacturing employment was basically unchanged from February. Order backlogs also dropped sharply in March, although that may be because the port strike settlement in late February enabled manufacturers to clear backlogs. In some more clearly bad news, export orders remained well below the 50 level that separates growth from contraction, falling from 48.5 in February to 47.5 in March. It will probably take either a pop in auto manufacturing or a restart of the housing industry to get the manufacturing data humming again. That's a real possibility by late summer, but probably not enough to help in the next month or two.
Job openings and budget data are all we have next week
Really slim pickings next week: The JOLT report will continue to be interesting, as it tends to either confirm or contradict some of the other recent employment data. We would love to see openings continue above the 5 million mark, but some minor slippage would not surprise us. In particular, we will be watching the level of quits, one of the best arbiters of a strong labour market and consumer confidence overall. March won't be a great month to get a handle on the federal budget deficit because it is a small revenue month--April data will give us an accurate picture.
